Financial Statement Analysis - NACM

[Pages:44]Financial Accounting

Financial Statement Analysis

Dr. Charles W. Mulford Scheller College of Business Georgia Institute of Technology

Atlanta, GA 30332-0520 (404) 894-4395

cwmulford@

Financial Accounting

C.Mulford: Financial Statement Analysis: 1

Profitability Ratios ? Gross margin ratio ? Operating income ratio ? R&D expense percent ? SGA expense percent ? Net margin ratio ? Effective tax rate ? Return on total assets ? Return on equity ? DuPont Analysis ? Economic value added (EVA)

Financial Analysis Ratio Formula Sheet

Gross profit / sales Sustainable operating income / sales R&D / sales SGA / sales Sustainable net income / sales Income tax provision / Income before taxes Sustainable net income / total assets Sustainable net income / shareholders' equity Net margin ratio X total asset turnover X total assets to equity (Return on total assets% ? Cost of capital%) x Total assets

Liquidity Ratios ? Current ratio ? Quick ratio ? Defensive interval

Current assets / current liabilities Cash + ST investments + accounts receivable / current liabilities Cash + ST investments + accounts receivable / Daily spending on operating expenses and interest

Leverage Ratios ? Total assets to equity ? Total liabilities to equity ? Debt to equity ? Times interest earned ? Altman's Z bankruptcy

? Book value per share

Activity Ratios ? Receivables turnover ? Days receivables ? Inventory turnover ? Days inventory ? Payables turnover ? Days payables ? Cash cycle ? Fixed assets turnover ? Cash cycle ? Days fixed assets ? Total assets turnover ? Days total assets

Cash Flow Ratio ? Net cash margin ? Capital expend. To depreciation

Valuation Ratios ? Earnings per share (EPS) ? Price / earnings ratios (PE) ? Price to book value

Total assets / shareholders' equity Total liabilities / shareholders' equity Debt financing / shareholders' equity EBITDA / interest expense 3.3(EBT/TA)+1.2(WC/TA)+.6(MktEq/BkDebt) 1.4(RE/TA) + 1(Revenue/TA) Common shareholders' equity / number of

shares outstanding

Revenue / accounts receivable 365 / receivables turnover Revenue / inventory 365 / inventory turnover Revenue / accounts payable 365 / payables turnover Days inventory - Days payables + Days receivables Revenue / PP&E Days inventory - Days payables + Days 365 / fixed assets turnover Revenue / total assets 365 / total assets turnover

Operating cash flow / sales Additions to PP&E / depreciation expense

Net income / common shares outstanding Market price / EPS Market price / book value per share

Financial Accounting

C.Mulford: Financial Statement Analysis: 2

Financial Statement Analysis

The financial statements for BGS Technologies are provided below:

BGS Technologies Income Statement Year Ended December 31, 2017

Sales

$ 1,000,000

Cost of goods sold

550,000

Gross profit

450,000

Research and development expense

100,000

Selling, general and admin. expenses

150,000

Operating income

200,000

Other income (expense): Special item ? Lawsuit settlement Special item ? Loss from flood Interest income Interest expense

(125,000) (25,000) 50,000 (25,000)

Income from continuing operations before taxes

75,000

Income tax provision

18,750

Income from continuing operations

56,250

Gain from discontinued operations (net of tax)

110,250

Net Income

$ 166,500

Financial Accounting

C.Mulford: Financial Statement Analysis: 3

BGS Technologies

Balance Sheet

As of December 31, 2017

Assets

Current Assets:

Cash and cash equivalents

$ 25,000

Short-term investments

50,000

Accounts receivable

80,000

Inventory

150,000

Total current assets

Property, Plant & Equipment:

Land

80,000

Buildings

475,000

Equipment, furniture & fixtures

310,000

Less: accumulated depreciation

(320,000)

Net property, plant and equipment

Total Assets

Liabilities and Stockholders' Equity

Current Liabilities:

Accounts payable

$ 55,000

Current portion of long-term debt

20,000

Income taxes payable

10,000

Total current liabilities

Noncurrent Liabilities: Long-term debt

Total liabilities

Stockholders' Equity: Common stock (100,000 shares) Additional paid-in capital Retained earnings

Total stockholders' equity Total Liabilities and Stockholders' Equity

10,000 290,000 315,000

$ 305,000

545,000 $ 850,000

$ 85,000 150,000 235,000

615,000 $ 850,000

Financial Accounting

C.Mulford: Financial Statement Analysis: 4

BGS Technologies Cash Flow Statement Year Ended December 31, 2017

Cash Provided (Used) by Operating Activities:

Net income Depreciation expense (Increase) Decrease in operating current assets Increase (Decrease) in operating current liabilities

Cash provided by operating activities

$ 166,500 32,000

(45,000) (8,000) 145,500

Cash Provided (Used) by Investing Activities: (Increase) in property, plant & equip. Decline in ST investments

Cash (used) in investing activities:

$ (315,000) 110,000

(205,000)

Cash Provided (Used) by Financing Activities: (Decrease) in long-term debt Dividends paid Increase in common stock Increase in additional paid in capital

Cash provided by financing activities Increase in cash and equivalents

(50,000) (30,000)

10,000 140,000

70,000 10,500

Cash and cash equivalents, beginning of year

14,500

Cash and cash equivalents, end of year

$ 25,000

Financial Accounting

C.Mulford: Financial Statement Analysis: 5

Analyzing the Income Statement How is BGS Technologies doing?

Financial ratios provide a framework for comparison with: ? Prior years ? Other companies in the same industry ? Other investment alternatives

Selected profitability ratios:

? Gross profit or gross margin ratio = gross profit / sales Measures percentage of each sales dollar available to cover selling, general and administrative expenses, financing costs, and to provide a return to investors. Measures basic profitability of company's product line.

For BGS Technologies: $450,000 / $1,000,000 = 45.0%

? Operating income ratio = operating income / sales Measures percentage of each sales dollar available to cover financing costs and to provide a return to investors. Measures overall profitability of core company operations, before interest and income tax effects.

For BGS Technologies: $200,000 / $1,000,000 = 20%

Before calculating the operating income ratio, operating income should be adjusted for included nonrecurring items. Examples include restructuring charges, merger-related expenses and acquired in-process research and development.

This adjustment is not applicable for BGS Technologies.

Financial Accounting

C.Mulford: Financial Statement Analysis: 6

A closer look at operating profit.

Two operating expense categories which can play a significant role in changes in operating profit over time are research and development (R&D) and Selling, general and administrative expense (SGA).

Management has more control over R&D and SGA spending than over cost of goods sold. Thus changes in operating profit over time can typically be more readily explained by changes in these expense categories than by changes in gross profit, which is determined by spending on cost of goods sold.

? R&D expense percent = R&D / sales Measures the percent of each sales dollar invested in research and development.

Changes in operating profit from one period to the next may be due to discretionary changes in research and development spending.

For BGS Technologies: $100,000 / $1,000,000 = 10%

? SGA expense percent = SGA / sales Measures the percent of each sales dollar spent on operating overhead.

Changes in operating profit from one period to the next may be due to discretionary changes in spending on SGA.

For BGS Technologies = $150,000 / $1,000,000 = 15%

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